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Special Edition Changing asset allocations

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Special Edition Changing asset allocations United States 24 March 2014 Changes to taxable asset allocations We are making some changes to our taxable fixed income asset allocations for the Moderate and
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Special Edition Changing asset allocations United States 24 March 2014 Changes to taxable asset allocations We are making some changes to our taxable fixed income asset allocations for the Moderate and Aggressive Profiles. The major changes are: a sizable shift from 1-to- 5 year maturities to both intermediate and long-term maturities, and a lowering of our overweight allocation to high yield bonds and developed country sovereign debt. We are adding to our allocations for TIPS and investment grade corporates. Martin Mauro Fixed Income Strategist MLPF&S Evan Richardson Fixed Income Strategist MLPF&S Rate hikes sooner could affect 2-5 year maturities most Our economists have pulled forward their expectation about a Fed rate hike, as has the market. Yields in the two-to-five year range are likely to show the greatest response to the prospective rise in short-term rates. Some of that has already happened, and we expect some more. Smaller overweight in high yield We are trimming our overweight allocation in high yield, because that sector would likely be hurt by rising 2-5 year yields. But we still believe that high yield will outperform Treasuries during the next 12 months. Higher yield, longer, but still below-market duration The extension in maturity raises the average yield of our allocations, and also the duration. But the duration remains below the market average. BofA Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 4 to 5. Link to Definitions on page Changing Asset Allocations We are making some changes to our taxable fixed income asset allocations for the Moderate and Aggressive Profiles. The major changes are: a sizable shift from 1-to-5 year maturities to both intermediate and long-term maturities, and a lowering of our overweight allocation to high yield bonds and developed country sovereign debt. We are adding to our allocation for both TIPS and investment grade corporates. What we changed and why In the wake of the March FOMC meeting our economics team pulled forward its expectation of the first Fed rate hike to the end of The market is expecting the action a bit sooner, around August Yields for 2-5 year Treasuries may rise more than others. Yields in the two-to-five year range are likely to show the greatest response to the prospective higher short-term rates. Some of that has already happened: since the Fed meeting, the yield spread between both three-month Treasury bills and two-year notes, and two-year and five-year notes have widened by nine basis points. Priya Misra, our rates strategist, believes that there is more to come. For the Moderate profile, we took 10% from the 1-5 year maturity bucket and put 7% in the 5-15 year bucket, and 3% in the 15 year and longer bucket. For the Aggressive Profiles we took 16% out of 1-5 years and added 14% to 5-to-15 years and 2% to 15 years and longer. The shift from short to intermediate and long-term maturities raises the average duration of our allocations, but we remain below the market. The average duration for the Moderate and Aggressive Profiles are 5.15 years and 5.45 years respectively. Those are both roundly 0.5 years longer than before, but still below the market duration of 5.94 years. High yield bonds might lose ground from higher 2-5 year yields, but they should still outperform Treasuries. TIPS and IG corporates may now be relatively undervalued. The maturity extension raises the average yields to 2.55% for the Moderate Profile and 2.74% for the Aggressive, increases of roundly 15 basis points. A rise in 5-year Treasury yields would probably do some damage to high yield (HY) bonds, since they are generally priced off of that maturity. Michael Contopoulos, our high yield strategist, argues that an improving economy, could, somewhat paradoxically, cause high yield spreads to widen, as investors begin to expect higher 5-year Treasury yields. That, added to the enormous outperformance in HY since the financial crisis, leads us to temper our overweight of HY. Our allocations for both the Moderate and Aggressive profiles remain above the 6% market weight because we think that yields remain high enough, and defaults are likely to remain low enough, for HY to outperform Treasuries during the next 12 months. We also lowered our allocation to developed country sovereign debt, based upon the declines in yield, and our expectation for a stronger dollar. For the Aggressive profile, we took 1% from Treasuries and added 2% to mortgage-backed securities. To balance these changes, we added 2% to the allocation for both TIPS and investment grade corporates. Although we don t see inflation as a near-term threat, breakeven inflation rates have declined this year. The strong rally in HY has greatly narrowed its yield spread over investment grade corporates. 2 24 March 2014 Table 1: Taxable fixed income asset allocation recommendations % of US Mkt New Previous (7/1/2013) Change from previous Maturity Conservative Moderate Aggressive Conservative Moderate Aggressive Conservative Moderate Aggressive 1-5 years 44% 100% 46% 40% 100% 56% 56% 0% -10% -16% 5-15 years 44% 0% 47% 51% 0% 40% 37% 0% 7% 14% 15+ years 12% 0% 7% 9% 0% 4% 7% 0% 3% 2% 100% 100% 100% 100% 100% 100% 100% 0% 0% 0% Sector Breakdown Treasuries 39% 40% 32% 30% 40% 32% 31% 0% 0% -1% TIPS 5% 3% 6% 6% 3% 4% 4% 0% +2% +2% Agencies 3% 35% 0% 0% 35% 0% 0% 0% 0% 0% Mort Backed Securities 23% 2% 23% 21% 2% 23% 19% 0% 0% +2% Inv Grade Corps 23% 20% 26% 24% 20% 24% 22% 0% +2% +2% Preferreds 1% 0% 1% 1% 0% 1% 1% 0% 0% 0% High Yield 6% 0% 7% 9% 0% 9% 12% 0% -2% -3% International: Developed NA 0% 1% 1% 0% 3% 3% 0% -2% -2% Emerging Mkts: USD NA 0% 2% 4% 0% 2% 4% 0% 0% 0% Emerging Mkts: Local NA 0% 2% 4% 0% 2% 4% 0% 0% 0% 100% 100% 100% 100% 100% 100% 100% 0% 0% 0% Estimated duration (yrs) * 4.72* 4.91* Estimated yield 2.48% 1.05% 2.55% 2.74% 1.05%* 2.42%* 2.58%* Source: BofA Merrill Lynch Global Research. Market values as of March close. *The duration and yield figures for the previous allocations apply the present market values (yields etc.) to the prior allocations. Link to Definitions Macro Click here for definitions of commonly used terms. 3 Important Disclosures BofA Merrill Lynch Research personnel (including the analyst(s) responsible for this report) receive compensation based upon, among other factors, the overall profitability of Bank of America Corporation, including profits derived from investment banking revenues. BofA Merrill Lynch Global Credit Research analysts regularly interact with sales and trading desk personnel in connection with their research, including to ascertain pricing and liquidity in the fixed income markets. Other Important Disclosures Rule 144A securities may be offered or sold only to persons in the U.S. who are Qualified Institutional Buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended. 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